financial(s) MATTER

8 May 2013

Navigating Australian capital flows The spending and saving behaviour of a cautious consumer
In the past 25 years, Australian households have
experienced a dramatic change in conditions. Interest rates and unemployment fell materially and remained low; all the while, financial innovation boomed.
120 100 80 60 40 20 0 -20 -40
Sources: ABS, Westpac Economics

Household worth rose dramatically

%
Net worth other* Net savings rate (rhs)
*Annual change in net worth, scaled by net disposable income. All data year to June.

% of net disposable income

Net worth super & insurance*

30

This facilitated significant changes in consumer spending,

saving and investing behaviour.

20

The 1990s saw households save little and increase their

leverage substantially as household net worth surged.

10

The tech bust and GFC resulted in Australian consumers

taking a hard look at their finances, but they are yet to deleverage in aggregate. To date, the leverage taken on by first home buyers and (at the margin) upgraders has offset reductions made by existing borrowers.

-10 1998 2001 2004 2007 2010

1989

1992

1995

The rise in the savings rate of the latter group points

to leveraged households building an immediate buffer against a cyclical shock (likely via mortgage offset accounts).

As households increased leverage

180 160 140 120 100 80 60 40 20 0 -20 Mar-77 Mar-87 Mar-97 Mar-07
0.1ppt pa

In tandem with our WestpacMI Consumer Sentiment

survey, information from the Financial Accounts indicates that consumers are unlikely to unwind this buffer soon. Indeed, adverse conditions may see it rise further. During 2012, we sought to outline Australias relative structural financial strengths. Specifically, we discussed the characteristics of: our net foreign debt (this burden ultimately lies with households, not the Australian Sovereign); our net foreign assets (diversified and of a significant scale); and, in the last edition, the idiosyncrasies of our current account (the growing importance of equity flows and the declining influence of private-sector debt). In this edition, we focus on the Australian consumer, their historical leveraging and new-found preference for saving. With the help of the annual National Accounts and the Financial Accounts releases, we go beyond the raw savings rate and look more deeply into households cash savings and their investment behaviour over the past two decades. Lessons learned In the past 25 years, Australian households have experienced a dramatic change in conditions. Over the three and a half years to September 1993, the standard variable mortgage rate almost halved to 8.75% as inflation pressures abated; it subsequently averaged 7.8% prior to the GFC rate-cut cycle. During those 15 years, the unemployment rate also declined by almost 7ppts to 4% as 3.2 million jobs were added, 62% of which were full time. Over this period, banks increasingly favoured housing. Mortgage debts outperformance in the 1990s recession, weak corporate credit demand thereafter, and mortgages favourable risk weighting under Basel I all supported a 16ppt increase in housing loans share of total bank lending, to 46% by 1995, and 58% by 2010 (The State of the Mortgage Market, Guy Debelle, 2010).
10 8 6 4 2

ratio to income (lhs) total debt owner occupier housing debt investor housing debt other debt

%
0.5ppt pa

180 160 140 120 100 80 60 40 20 0 -20

+0.8ppt pa

1.1ppt pa
Sources: RBA, Westpac

Rise in debt more than an adjustment to low rates

%
Interest expense* (lhs) Standard variable mortgage rate (rhs)
*% of net disposable income. All data year to June.

20 16 12 8 4

0 1960

Sources: ABS, RBA, Westpac Economics

1970

1980

1990

2000

2010

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

financial(s) MATTER
8 May 2013
Given the favourable environment, it is little wonder that Australian households took advantage of the growing availability of debt. The increased use of debt was primarily focused on housing. Lower inflation brought with it expectations of lower interest rates, while the strong employment outcomes noted above gave households greater confidence in their ability to service and pay down debt. Strong gains for asset prices (property and shares) gave owner-occupier activity an additional boost, and also enticed investors. However, there is another part to this story which is often overlooked: the introduction and progressive development of the compulsory superannuation system. While superannuation had been around for decades, the decade to 2003 saw the introduction and subsequent development (the increase in the contribution rate from 4% to 9%) of the compulsory super system. Coupled with growing confidence in the broad economic outlook, households greater security in their own long-term personal finances gave Australian households the assurance necessary to bring forward investment and consumption by borrowing. It is striking that, when we subtract employer superannuation and workers compensation contributions from net savings, the net savings rate spends close to 20 years below zero. (This does not necessarily mean that households did not accrue savings over this period. The numerous imputed cash flows included in the household income and expenditure accounts make it nigh on impossible to conclude this from the National Accounts.) However, what we can conclude is that the 1990s and 2000s saw a significant increase in household leverage, with the rate of growth relative to income tapering a little in 2004, then stabilising in the wake of the GFC. While there has been much talk of deleveraging post GFC, relative to household disposable income, Australian households have really only stopped leveraging in aggregate. Debt for owneroccupied housing has continued to increase at a marginal rate, offset by a modest fall in personal and investor lending. By household type, it is apparent that the leverage taken up by first home buyers and upgraders since the GFC has been largely offset by repayments made by already mortgaged households. Another way to highlight the absence of aggregate deleveraging in the Australian experience is to contrast it to the US: there, household debt relative to income has declined for going on five years. The divergence between the Australian and US experience has principally come about owing to the strength of the Australian labour market and banking system as well as the impact of forced deleveraging in the US (loan defaults). Australian households have been able to learn a valuable lesson from afar, and have accordingly adjusted their own behaviour, taking a more cautious approach to debt. Household investment decisions: an alternative perspective As noted above, while we are unable to clearly assess households cash saving behaviour from the National Accounts due to imputed cash flows, the Financial Accounts publication gives clearer guidance on the investment and financing behaviour of Australian households. The information in this release is quite telling; it is also consistent with the message provided by our WestpacMelbourne Institute Consumer Sentiment Index. The first two observations that can be drawn from the data are that Australian households have typically favoured contributing to super and building up deposit holdings versus directly investing in equities or debt instruments.

The household savings rate includes super

30 %
% of household net disposable income
Net savings ex super* (lhs) Net savings rate (lhs) Gross household debt (rhs)
*Excludes superannuation and workers compensation contributions made by employers. RBA historical data used as proxy prior to 1990. All data annual; year to June.

180

20

120

10

60

0
Sources: ABS, RBA, Westpac Economics
Compulsory super introduced Reaches 9%

-10 1960

-60 1970 1980 1990 2000 2010

US was forced to deleverage

130 120 110 100 90 80 70 1990
Sources: BEA, RBA, Westpac Economics

%
Australia (rhs)

debt to disposable income

United States (lhs)

160 140 120 100 80 60 40

1994

1998

2002

2006

2010

Aus HHs financial investment decisions

30 %
Deposits
*4Q sum

% of compensation of employees
Superannuation Debt instruments Equity

30

20

20

10

10

-10 1989

Sources: ABS, Westpac Economics

-10 2009

1994

1999

2004

Consistent with WestpacMI trend

60 50 40 30 20 10 0 Mar-98
Sources: Westpac, Melbourne Institute

wisest place for savings

60 50 40 30 20 10 0

shares deposits/super
seasonally adjusted by Westpac *repay debt and super options only included from 1997

real estate repay debt*

Mar-01

Mar-04

Mar-07

Mar-10

Mar-13

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

financial(s) MATTER
8 May 2013
The minimal flow into debt instruments is arguably more due to an absence of AUD denominated supply, not demand. The very limited flow into equities other than at the height of global equity manias (the late 1990s tech boom and pre-GFC period) is more surprising, particularly given the rise in online stockbroking and pro-equity news flow in the decade before the GFC. Arguably households appetite for equities is being met indirectly via their superannuation holdings. The trends apparent in the superannuation and deposits series deserve closer attention. First, it is clear that Australian households value superannuation; encouraged by its tax effectiveness, households have contributed more than the mandated minimum contribution throughout the entire history of the series. The effectiveness of additional incentives (such as the lump-sum contribution tax breaks provided mid decade) can also be seen in the data. Despite the winding down of these incentives over the past five years, households preference for putting additional savings away for retirement has remained strong. Baby boomers are likely to be the dominant force behind this trend. Turning to deposits, it is apparent from the data that Australian households saw little need to actively store away freely-available cash (i.e. deposits) through much of the 1990s. This is not surprising given the macro-financial trends discussed above (income growth; lower interest rates; and rising net worth). However, at the turn of the millennium, there seems to have been a shift in consumers saving behaviour. From a low of 0.64% in late 1999, the flow into deposits rose by over 10ppts to 11.1% in March 2002. The initial shift in consumer behaviour likely had a lot to do with the US tech wreck and September 11. However, this change in behaviour looks to have lingered on well after these events: the average flow into deposits over the subsequent six years was almost three times that seen over the decade to December 2000. Given that Australian households continued to lever up in the lead-up to the GFC, it does not seem appropriate to conclude that the events of 2000/01 materially and permanently impacted consumers appetite for debt. Rather, it seems Australian households became more focused on building a deposit buffer to protect from negative cyclical shocks, all the while still remaining open to using leverage to invest and consume as opportunities arose. The use of mortgage offset accounts likely facilitated this trend. These accounts allow mortgage holders to save for a rainy day and mitigate interest expense while still maintaining access to the funds. This trend has continued since. The generally favourable macroeconomic backdrop and low interest rates have seen first home buyers continue to enter the market albeit often sporadically but existing home owners caution has persisted. Where to from here? Retailers may well be wondering, given the rise seen in savings over the past six years, the relatively solid state of the labour market, robust house prices and recent share market gains, why arent consumers willing to spend more? The answer comes down to confidence in the macro-economic outlook and the reason the aforementioned savings exist. Simply, to the extent that these savings look as though they are often held by leveraged households as a buffer against potential negative cyclical events, they will not be used for consumption until necessary (a cyclical shock occurs), or the reasons to expect a negative event(s) diminish from sight.

Labour market concerns remain elevated

200 180 160 140 120 100 80 Apr-88
unemployment expected to fall

index
unemployment expectations unemployment expectations trend
unemployment expected to rise peak, Feb 09

index
Sources: Westpac-MI

200 180 160 140 120 100

Apr-93

Apr-98

Apr-03

Apr-08

80 Apr-13

Consumer caution still clearly apparent

103 102
less conservative

index
more conservative

% 12 10 8

101 100 99
Source: RBA, Westpac Group

Westpac household barometer (lhs)* household savings ratio (rhs)

*based on: card transactions, mortgage prepayments; credit card usage; and card debt repayment behaviour

6 4 2 0 -2

98 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

Consumer confidence is currently only marginally above long-run average levels. And, while they have improved, unemployment expectations remain at a high level. Ergo, while consumers feel that now is a good time to buy, their collective perception of value is not translating fully into actual sales because households remain wary of the outlook and still regard themselves as being vulnerable to shocks. Our own household barometer concurs, indicating consumers remain highly conservative. As evinced by the recent developments in Greece and Cyprus and the more general political concerns over Italy and Spain, many potential triggers for financial and economic instability remain throughout Europe and indeed the world. Domestically, we are also yet to see concrete evidence that non-mining activity will be able to support trend GDP growth following the peak in the mining investment boom. Indeed, recent survey and partial macro data suggests the opposite is true. Both the NAB business survey and the ACCIWestpac Survey of Industrial Trends point to weak conditions in the non-mining sector. And, even before the mining investment boom peak has been reached, jobs growth has weakened to be considerably below population growth. Overall, it is clear that leveraged households have sought to build a buffer against existing liabilities in addition to super. However, this has not resulted in material deleveraging as the relative strength of the Australian economy has supported new borrowers entering the housing market. Leveraged consumers are willing to boost consumption sporadically, but they also remain susceptible to shocks. Given the uncertainty around the domestic economy post mining investment boom and the lingering global uncertanties, persistent strength in consumption seems unlikely until a more certain, positive outlook is in view. Elliot Clarke, Economist +61 (2) 8253 8476

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

Disclaimer

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